H.R. 3221, the “Housing Assistance Tax Act of 2008” (the Housing Act), was passed by the House of Representatives on July 23 and, in an unusual Saturday session, by the Senate on July 26. President Bush dropped its earlier opposition to the measure and signed the Act into Law on July 30, 2008. 

In addition to provisions designed to shore up the ailing housing market, tighten lending practices, reform financial institutions associated with that market, provide help for some debt-plagued homeowners, provide authority for Treasury to make sure that Freddie-Mac and Freddie-Mae don't fail, and numerous other non-tax authorizations, the new law also contains a 96-page tax section called the Housing Assistance Tax Act of 2008 (referred to as the Housing Act in this analysis.)  

The Housing Act includes the following tax changes:

• Tax breaks for homebuyers and homeowners,
• Liberalized low-income housing tax credit rules,
• Relaxed requirements for tax-exempt bonds,
• Eased AMT rules,
• Tax breaks for business,
• Revamped REIT rules, and
• A number of other specialized provisions.

The $14-billion-plus price tag for the tax title is fully offset with new rules requiring information reporting of payment card and third party network transactions, a delay in the application of worldwide allocation of interest, and revised 2012 and 2013 estimated tax rules for large corporations.

 

New Tax Credit for First-Time Homebuyers

Present Law. Under pre-Act law, first-time homebuyers of a principal residence in the District of Columbia were eligible for a nonrefundable tax credit of up to $5,000 of the amount of the purchase price, phasing out at statutory levels of modified adjusted gross income. The credit expired for residences purchased after Dec. 31, 2007.

New law. The Act gives eligible first-time homebuyers a refundable tax credit equal to the lesser of 10% of the purchase price of a principal residence or $7,500 ($3,750 for married individuals filing separately). (Code Sec. 36, as amended by Act § 301)

The credit, which is generally allowed for the tax year in which the principal residence is bought, phases out for individual taxpayers with modified adjusted gross income (AGI) between $75,000 and $95,000 ($150,000-$170,000 for joint filers) for the year of purchase. A taxpayer is considered a first-time homebuyer if he (or spouse, if married) had no present ownership interest in a principal residence in the U.S. during the 3-year period before the purchase of the home to which the credit applies.

Observation: Because only prior ownership in a principal residence is considered, it's possible (albeit unlikely) for a taxpayer who already owns a vacation home to claim the new credit, if he otherwise qualifies. For example, a taxpayer whose principal residence for at least three years has been a rental apartment in the city, and who owns a seaside home he inherited from his parents, could claim the credit for the purchase of a new principal residence if his modified AGI doesn't exceed the phaseout levels.

No credit is allowed if:

• The D.C. homebuyer credit is allowable for the tax year the residence is bought (i.e., if the D.C. homebuyer credit is extended, as it has been several times before) or a prior tax year;
• The taxpayer's financing is from the proceeds of tax-exempt mortgage revenue bonds;
• The taxpayer is a nonresident alien;
• The taxpayer disposes of the home (or it ceases to be a principal residence) before the close of a tax year for which a credit otherwise would be allowable.

Any home purchase (including, presumably, coops and condos) qualifies but only if (1) the property isn't acquired from a person related to the buyer (under detailed rules in new Code Sec. 36(c)(5) ); and (2) the basis of the property in the hands of the buyer is not determined by reference to the adjusted basis of the property in the hands of the person from whom it was acquired, or under Code Sec. 1014(a) (property acquired from a decedent).

A home under construction by a taxpayer is treated as purchased by him on the date he first occupies it.

Regular recapture rule. The credit for new homebuyers is recaptured ratably over fifteen years, with no interest charge, beginning with the second tax year after the tax year in which the home is purchased. For each tax year of the 15-year recapture period, the credit is recaptured as an additional income tax amount equal to 6 2/3% of the amount of the credit. (Code Sec. 36(f)(1), Code Sec. 36(f)(7))

Observation: In other words, the credit for new homebuyers is, as a practical matter, the equivalent of an interest-free loan from the government.

Illustration : Frank and Mary Smith, eligible taxpayers with modified AGI below the phaseout limits, buy a $200,000 principal residence in August of 2008. They may claim a first-time homebuyer credit of $7,500 on their 2008 income tax return (lesser of $20,000 (10% of the $200,000 cost of the home) or $7,500). On their income tax return for 2010, the Smiths will pay an additional income tax amount equal to $500 (6 2/3% of $7,500). They also will pay an additional income tax of $500 on their income tax returns for tax years 2011 through 2014 (assuming they own the home and use it as a principal residence for that period).

Accelerated recapture rule. If a taxpayer who claims the credit for new homebuyers sells the home (or he or his spouse no longer use it as a principal residence) before complete repayment of the credit, any remaining credit repayment amount is paid with the tax return for the year in which the home is sold (or ceases to be used as the principal residence). However, the credit repayment amount can't exceed the gain from the sale of the residence to an unrelated person. For this purpose, gain is determined by reducing the home's basis by the amount of the credit to the extent not previously recaptured. (Code Sec. 36(f)(2), Code Sec. 36(f)(3))

Neither the regular nor the accelerated recapture rules apply to any tax year ending after the taxpayer's death of death. Additionally, if the home is involuntarily converted (e.g., it's destroyed in a storm), and the taxpayer buys a new principal residence within a two year period beginning on the date of the disposition or the date the home ceases to be the principal residence), (1) the accelerated recapture rule does not apply, but (2) the regular recapture rule applies to the replacement principal residence during the recapture period in the same way as if the replacement principal residence were the converted residence. (Code Sec. 36(f)(4))

In the case of a transfer of the residence to a spouse or to a former spouse incident to divorce, the accelerated recapture rule won't apply to the transfer, but both the regular and accelerated recapture rules will apply to transferee spouse (and not the transferor spouse) who will be responsible for any future recapture.

Effective date. The new homebuyer credit applies for qualifying home purchases after Apr. 8, 2008 and before July 9, 2009. (The Committee Report says this applies whether or not there was a binding contract to purchase the home before Apr. 9, 2008).

Election for 2009 buyers to accelerate credit into 2008. Eligible first-time homebuyers who purchase a principal residence after Dec. 31, 2008, and before July 1, 2009, may elect to treat the purchase as made on Dec. 31, 2008. (Code Sec. 36(g)).

Observation: The election effectively allows eligible first-time homebuyers who make a timely purchase in 2009 to claim the credit on their 2008 returns rather than on their 2009 returns.

 

New Property Tax Deduction for Non-Itemizers

The Act permits taxpayers who claim the standard deduction instead of itemizing deductions to claim an additional standard deduction for State and local property taxes paid. The deduction, which applies only to a tax year beginning in 2008, can't exceed the lesser of State and local property taxes actually paid or $500 ($1,000 for joint return filers). (Code Sec. 63(c)(7), as amended by Act § 3012)

Taxes taken into account in arriving at adjusted gross income under Code Sec. 62(a) aren't taken into account in computing the new property tax deduction. (Code Sec. 63(c)(7))

 

Reduced Homesale Exclusion for Nonqualified Use Periods

Present Law: Under Code Sec. 121(a), a taxpayer can exclude from income up to $250,000 of gain from the sale of a home owned and used by the taxpayer as a principal residence for at least 2 of the 5 years before the sale. The full exclusion doesn't apply if, within the 2-year period ending on the sale date, the exclusion applied to another home sale by the taxpayer. Married taxpayers filing jointly for the year of sale may exclude up to $500,000 of homesale gain if (1) either spouse owned the home for at least 2 of the 5 years before the sale, (2) both spouses used the home as a principal residence for at least 2 of the 5 years before the sale, and (3) neither spouse is ineligible for the full exclusion because of the once-every-2-year limit.

Under an election available to members of the uniformed services, the Foreign Service, and certain employees of the intelligence community, the 5-year period ending on the date of the sale or exchange of a principal residence does not include any period up to 10 years during which the taxpayer or the taxpayer's spouse is on qualified official extended duty.

The homesale exclusion doesn't apply to gain attributable to post-May 6, '97 depreciation claimed for rental or business use of a principal residence.

A reduced maximum exclusion may apply to taxpayers who sell their principal residence but (1) fail to qualify for the 2-out-of-5-year ownership and use rule, or (2) previously sold another home within the two year period ending on the sale date of the current home in a transaction to which the exclusion applied. If the taxpayer's failure to meet either rule occurs because he must sell the home due to a change of place of employment, health, or to the extent provided by regs, other unforeseen circumstances, then he may be entitled to a reduced maximum exclusion. Under these circumstances, the maximum gain that can be excluded is equal to the full $250,000 or $500,000 exclusion times a fraction having as its numerator the shorter of (a) aggregate periods of ownership and use of the home by the taxpayer as a principal residence during the 5 years ending on the sale date, or (b) the period of time after the last sale to which the exclusion applied, and before the date of the current sale, and having 2 years (or its equivalent in months) as its denominator.

New law. For sales and exchanges after Dec. 31, 2008, the homesale exclusion won't apply to the extent gain from the sale or exchange of a principal residence is allocated to periods of nonqualified use. (Code Sec. 121(b)(4), as amended by Act § 3092) Generally, nonqualified use is any period (other than the portion of any period before Jan. 1, 2009) during which the property is not used as the principal residence of the taxpayer or spouse. However, nonqualified use does not include:

• Any portion of the Code Sec. 121(a) 5-year period which is after the last date that the property is used as the principal residence of the taxpayer or spouse;
• Any period (not to exceed an aggregate period of 10 years) during which the taxpayer or spouse is serving on qualified official extended duty; and
• Any other period of temporary absence (not to exceed an aggregate period of 2 years) due to change of employment, health conditions, or other unforeseen circumstances specified by IRS. (Code Sec. 121(b)(4)(C))

The amount of gain allocated to periods of nonqualified use is the amount of gain multiplied by a fraction where the numerator is the aggregate periods of nonqualified use during the period the property was owned by the taxpayer and the denominator of which is the period the taxpayer owned the property. (Committee Report)

Illustration: Jack Able, a single taxpayer, bought a home on Jan. 1, 2009, for $400,000, and uses it as rental property for two years claiming $20,000 of depreciation deductions (thereby reducing his basis in the home to $380,000). On Jan. 1, 2011, he converts the property to his principal residence. On Jan. 1, 2013, Jack moves out of the home and sells it for $700,000 on Jan. 1, 2014, and thus has a gain of $320,000 ($700,000 − $380,000).

Under pre-Act law, Jack would have $20,000 of gain included in income (taxed at 25% as “unrecaptured section 1250 gain”), and would have excluded $250,000 of his gain (because he had two full years of ownership). The $50,000 balance of his long-term gain would have been taxed at a maximum rate of 15%.

Under the Housing Act change, the same $20,000 of gain attributable to Jack's depreciation deductions is included in income (and taxed at 25%). Of the remaining $300,000 gain, 40% (2 years ÷ 5 years), or $120,000, is allocated to nonqualified use and is not eligible for the exclusion (and is taxed at maximum rate of 15%). The remaining gain of $180,000 is excluded under Code Sec. 121 , since it's less than the maximum excludible gain of $250,000.

Illustration: Joan Baker, a single individual, buys a principal residence on Jan. 1, 2009, for $400,000, moves out on Jan. 1, 2019, and on Dec. 1, 2021 sells the property for $600,000. The entire $200,000 gain is excluded from gross income under the Act, because periods after the last qualified use do not constitute nonqualified use. (Committee Report)

Coordination with recognition of gain attributable to depreciation. For determining the amount of gain allocated to nonqualified use of a principal residence, the following rules will apply:

• The rule providing that gain allocated to periods of nonqualified use does not qualify for the exclusion is applied after the application of Code Sec. 121(d)(6) (rules providing that gain attributable to post-May 6, '97 depreciation does not qualify for the exclusion), and
  
• The rules providing for the allocation of gain to periods of nonqualified use are applied without regard to any gain to which Code Sec. 121(d)(6) (rules providing that gain attributable to post-May 6, '97 depreciation does not qualify for the exclusion) applies. (Code Sec. 121(b)(4)(D))

 

Low-Income Housing Credit and Rehab Credit
May Offset AMT

The alternative minimum tax (AMT) is the amount by which the tentative minimum tax exceeds the regular income tax. Under pre-Act law, business tax credits generally can't exceed the excess of a taxpayer's income tax liability over the tentative minimum tax (or, if greater, 25% of the regular tax liability in excess of $25,000). Thus, business tax credits generally cannot offset AMT liability. Credits in excess of the limit may be carried back one year and carried forward for up to 20 years.

New law. Under the Act, the low-income housing tax credit and rehabilitation credit offset AMT liability. The Act accomplishes this result by treating the tentative minimum tax as being zero for determining the tax liability limit for the low-income housing credit and the rehabilitation credit. (Code Sec. 38(c)(4)(B)(ii) and Code Sec. 38(c)(4)(B)(v), as amended by Act § 3012)

Effective date. The above AMT changes applies for low-income housing credits determined under Code Sec. 42 attributable to buildings placed in service after Dec. 31, 2007, and for rehabilitation credits determined under Code Sec. 47 to the extent attributable to qualified rehabilitation expenses properly taken into account for periods after Dec. 31, 2007.

 

Interest Earned on Exempt Facility, Qualified Residential Rental, and Veterans' Mortgage Bonds
Isn't an AMT Preference

The starting point to compute alternative minimum tax (AMT) is the taxpayer's taxable income, which is modified to take into account certain preferences and adjustments. One of the preference items is tax-exempt interest on certain tax-exempt bonds issued for private activities. Also, the corporate AMT adjustment based on current earnings is determined, in part, by taking into account 75% of items, including tax-exempt interest, that are excluded from taxable income but included in the corporation's earnings and profits (E&P).

New law. For bonds issued after the enactment date, the Act provides that tax-exempt interest earned on the following instruments is not a preference item for AMT purposes:

(1) exempt facility bonds issued as part of an issue 95% or more of the net proceeds of which are used to provide qualified residential rental projects (as defined in Code Sec. 142(d) )

(2) qualified mortgage bonds (as defined in Code Sec. 143(a) ); and

(3) qualified veterans' mortgage bonds (as defined in Code Sec. 143(b)) (Code Sec. 57(a)(5)(C)(iii), as amended by Act § 3022(a)(1))

The above changes don't apply to interest on any refunding bond unless interest on the refunded bond (or in the case of a series of refundings, the original bond) was not an item of tax preference.

Additionally, tax-exempt interest earned on the above three types of bonds is not included in the corporate AMT adjustment based on current earnings. (Code Sec. 56(g)(4)(B)(iii), as amended by Act § 3022(a)(2))

 

FHLB-Guaranteed State & Local Bonds
Eligible for Tax-Exempt Bond Treatment

Interest on sate and local government bonds generally is excluded from gross income, but not if the bonds are treated as federally guaranteed under Code Sec. 149(b)(2) . Pre-Act law excepted certain guarantee programs from this rule (e.g. guarantees by the Federal Home Loan Mortgage Corporation (FHLMC) or the Government National Mortgage Association (GNMA)), but there was no exception for bonds backed by a Federal home loan bank (FHLB).

New law. The Act provides that bonds issued by state and local governments are not treated as federally guaranteed because of any guarantee by a FHLB made in connection with the original issuance of a bond during the period beginning on the enactment date and ending on Dec. 31, 2010 (or a renewal or extension of a guarantee so made). (Code Sec. 149(b)(3)(A)(iv), as amended by Act § 3023(a)) The new exception doesn't apply unless the FHLB meets safety and soundness collateral requirements for such guarantees that are at least as stringent as the requirements for such FHLB guarantees as in effect on Apr. 9, 2008. (Code Sec. 149(b)(3)(E), as amended by Act § 3023(b)) The change is effective for guarantees made after the enactment date.

 

 

Election to Accelerate AMT & research credits
Instead of bonus depreciation

Under the first-year bonus depreciation rules in Code Sec. 168(k), taxpayers may claim an additional first-year depreciation deduction equal to 50% of the adjusted basis of qualified property generally placed in service in 2008. The first-year bonus depreciation deduction is allowed for both regular tax and AMT purposes for the tax year in which the property is placed in service. The basis of the property and the depreciation allowances in the year the property is placed in service and later years are appropriately adjusted to reflect the additional first-year depreciation deduction.

For corporations subject to the AMT in any year, the amount of AMT paid is allowed as a credit in any subsequent tax year to the extent regular tax liability exceeds tentative minimum tax.

As part of the general business credit, Code Sec. 38 limits credits for increasing research activities generally to the amount of regular tax in excess of tentative minimum tax.

New law. For tax years ending after Mar. 31, 2008, the Act provides that corporations otherwise eligible for bonus depreciation may instead elect to claim additional research or minimum tax credits for eligible qualified property placed in service after Mar. 31, 2008. (Code Sec. 168(k)(4), as amended by Act § 3081(a))

A corporation making the election forgoes the depreciation deductions allowable under Code Sec. 168(k) and instead increases the Code Sec. 38(c) limit on the use of research credits or the Code Sec. 53(c) limit on the use of minimum tax credits. (Code Sec. 168(k)(4)(B)) The increases in the allowable credits are treated as refundable for purposes of the new rule. The depreciation for qualified property is calculated for both regular tax and AMT purposes using the straight-line method in place of the method that would otherwise be used absent the new election. (Code Sec. 168(k)(4)(A)(i))

The research credit or minimum tax credit limitation is increased by the bonus depreciation amount. This is an amount equal to 20% of any excess of:

(a) the aggregate amount of depreciation which would be allowed under Code Sec. 168(k) for eligible qualified property placed in service during the tax year if the bonus depreciation rule of Code Sec. 168(k)(1) applied to all such property; over

(b) the aggregate amount of depreciation which would be allowed under Code Sec. 168(k) for eligible qualified property placed in service during the tax year if the bonus depreciation rule of Code Sec. 168(k)(1) did not apply to any such property. (Code Sec. 168(k)(4)(C)(i))

The aggregate amounts in (a) and (b), above, are determined without regard to any election to use straight line depreciation.

Generally, eligible qualified property included in the calculation is bonus depreciation property that meets the following requirements:

(1) the original use of the property commences with the taxpayer after Mar. 31, 2008;

(2) the taxpayer purchases the property either (a) after Mar. 31, 2008, and before Jan. 1, 2009, but only if no binding written contract for the acquisition is in effect before Apr. 1, 2008, or (b) pursuant to a binding written contract which was entered into after Mar. 31, 2008, and before Jan. 1, 2009; and

(3) the property must be placed in service after Mar. 31, 2008, and before Jan. 1, 2009 (Jan. 1, 2010 for certain longer-lived and transportation property). (Code Sec. 168(k)(4)(D))

The bonus depreciation amount is limited to the lesser of: (1) $30 million, or (2) 6% of the sum of research credit carryforwards from tax years beginning before Jan. 1, 2006 and minimum tax credits allocable to the adjusted minimum tax imposed for tax years beginning before Jan. 1, 2006. (Code Sec. 168(k)(4)(C)(iii)) All corporations treated as a single employer under Code Sec. 52(a) are treated as one taxpayer for purposes of the limitation, as well as for electing the application of new Code Sec. 168(k)(4). (Code Sec. 168(k)(4)(C)(iv))

Act § 3081(b) carries special election rules that apply to only one automotive partnership (probably Cerberus Capital Management, LP, owner of Chrysler).

 

Implementation of Worldwide Interest Allocation
Is Delayed

The American Jobs Creation Act of 2004 gave taxpayers an election to take advantage of a liberalized rule for allocating interest expense between U.S. sources and foreign sources for purposes of determining a taxpayer's foreign tax credit limitation. Under pre-Act law, this election is not available to taxpayers until tax years beginning after 2008.

New law. The Act delays the phase-in of this new liberalized rule for two years (to tax years beginning after 2010). (Code Sec. 864(f), as amended by Act § 3093(a)) Special transition rules apply in the first year that the liberalized rule phases in. (Code Sec. 864(f)(7))

 

Information Reporting of Merchants' Credit Card and
Third-Party Network Sales—After 2010

A variety of information reporting requirements apply to participants in certain transactions. These requirements are intended to assist taxpayers in preparing their income tax returns and to help IRS determine whether such returns are correct and complete. Pre-Act law does not require reporting of credit card sales and similar transactions.

New law. After 2010, the Act generally requires banks and third-party payment networks facilitating online sales to file an information return with IRS reporting the gross amount of credit and debit card payments a merchant receives during the year, along with the merchant's name, address, and taxpayer identification number (TIN). Similar reporting is also required for third party network transactions. (Code Sec. 6050W, as added by Act § 3091(a)) The object of the information reporting requirement is to boost the compliance rate of merchants.

What follows is a brief overview of the key terms, definitions, and requirements that apply to this sweeping new rule, projected to bring in over $9.8 billion in a ten-year period.

• The information reporting burden falls on any payment settlement entity making payment to a participating payee in settlement of reportable payment transactions. (Code Sec. 6050W(a))
  
• A payment settlement entity is, for a payment card transaction, a merchant acquiring entity (the bank or other organization with the contractual obligation to make payment to participating payees in settlement of payment card transactions). For a third party network transaction, a payment settlement entity is the third party settlement organization, namely the central organization which has the contractual obligation to make payment to participating payees of third-party network transactions. (Code Sec. 6050W(b))
  
• A reportable payment transaction is any payment card (e.g., credit or debit card) transaction and any third party network transaction (any transaction which is settled through a third party payment network). (Code Sec. 6050W(c))
  
• A participating payee means, for a payment card transaction, any person who accepts a payment card as payment and, for a third party network transaction, any person who accepts payment from a third party settlement organization in settlement of such a transaction. (Code Sec. 6050W(d))
  
• A third party settlement organization must make an information report with respect to third party network transactions of any participating payee only if the annual amount of such transactions exceeds $20,000 and the aggregate number of such transactions for the year exceeds 200. (Code Sec. 6050W(e))
  
• Reportable payment transactions subject to information reporting generally are subject to backup withholding requirements and failure to file penalties apply for noncompliance. (Code Sec. 3406(b)(3), Code Sec. 6724(d))

Effective date. The new reporting requirement is effective for information returns for reportable payment transactions for calendar years beginning after Dec. 31, 2010. The backup withholding requirements apply to amounts paid after Dec. 31, 2011. (Act § 3091(e))

 

Real Estate Investment Trust (REIT) Rules Liberalized

A REIT is an entity that otherwise would be taxed as a U.S. corporation but elects to be taxed under a special REIT tax regime. To qualify as a REIT, an entity must meet a number of requirements. At least 90% of REIT income (other than net capital gain) must be distributed annually; the REIT must derive most of its income from passive, generally real-estate-related investments; and REIT assets must be primarily real-estate-related. In addition, a REIT must have transferable interests and at least 100 shareholders, and no more than 50% of the REIT interests may be owned by 5 or fewer individual shareholders.

The portion of a REIT's income that is distributed to its shareholders each year as a dividend is deductible by the REIT and thus is not taxed at the entity level, only at the investor level.

New law. As separately discussed in the paragraphs that follow, generally effective for tax years beginning after the enactment date, the Act liberalizes the REIT rules by, among other items, clarifying that REITs can earn foreign currency income associated with real estate activities, increasing the permissible size of REIT investments in taxable REIT subsidiaries, modifying the REIT safe harbor for dealer sales, and extending the special rules for lodging facilities to health care facilities.

 

Exclusion of Foreign Currency Gain
Under REIT Income Tests

At least 75% of a REIT's gross income in each tax year must consist of real-estate-related income, such as real property rents (the 75% income test). In addition, 95% of the gross income of a REIT for each tax year must be from the 75% income sources and a second permitted category of other, generally passive investments such as dividends, capital gains, and interest income (the “95% income test”).

Foreign currency exchange gain is not explicitly included in the statutory definitions of qualifying income under either test but IRS has issued guidance that allows foreign currency gain to be treated as qualified income in certain circumstances.

The foreign currency transaction rules of Code Sec. 985 through Code Sec. 989 apply whenever a taxpayer engages in a business or investment activity using a currency other than the taxpayer's functional currency (a “nonfunctional currency”). Code Sec. 985 provides in general that all determinations for Federal income tax purposes are made in the taxpayer's functional currency. A taxpayer's functional currency is the dollar except in the case of a qualified business unit (QBU), in which case the functional currency is the currency of the economic environment in which a significant part of such unit's activities are conducted and which is used by such unit in keeping its books and records.

A taxpayer that engages in a business or investment activity using a currency other than the U.S. dollar may have gain or loss under Code Sec. 987 or Code Sec. 988 , depending on the nature of the activity and type of entity (if any) through which the activity is conducted.

New law. For gains and items of income recognized after the enactment date, the Act excludes certain foreign currency gain recognized under Code Sec. 987 or Code Sec. 988 from the computation of qualifying income for purposes of the 75% income test or the 95% income test. The exclusion is solely for purposes of the computations under these tests. (Code Sec. 856(n), as added by Act § 3031)

The Act defines two new categories of income for purposes of the exclusion rules: “real estate foreign exchange gain” and “passive foreign exchange gain.” Real estate foreign exchange gain is excluded from gross income for purposes of both the 75% and 95% income tests. Passive foreign exchange gain is excluded for purposes of the 95% income test but is included in gross income and treated as nonqualifying income to the extent that it is not real estate foreign exchange gain, for purposes of the 75% income test. (Code Sec. 856(n))

Except in the case of certain income that is excluded under the hedging rules of Code Sec. 856(c)(5)(G) (as amended by Act), any Code Sec. 988 gain derived from engaging in dealing, or substantial and regular trading, in securities constitutes gross income that does not qualify under either the 75% or 95% income test. (Code Sec. 856(n)(4))

Under the Act, for gain recognized after the enactment date, permitted foreclosure property income also includes foreign currency gain that is attributable to otherwise permitted income from foreclosure property. (Code Sec. 857(b)(4)(B), as amended by Act § 3033(a))

 

Exclusion of Hedging and Other Income
Under REIT Income Tests

As discussed above, REITs are subject to a 75% income test and a 90% income test.
Except as provided by regs, income from a hedging transaction that is clearly identified, including gain from the sale or disposition of such a transaction, is not included as gross income under the 95% income test, to the extent the transaction hedges any indebtedness incurred or to be incurred by the REIT to acquire or carry real estate assets.

New law. For transactions entered into after the enactment date, the Act extends the pre-Act rule of Code Sec. 856(c)(5)(G), which excludes certain hedging income from the computation of the 95% income test, to exclude such hedging income from the computation of the 75% income test as well. (Code Sec. 856(c)(5)(G)(i), as amended by Act § 3031(b))

The Act extends Code Sec. 856(c)(5)(G) to encompass, (except to the extent determined by IRS), income of a REIT from a transaction entered into by the REIT primarily to manage risk of currency fluctuations with respect to any item of income or gain that would be qualified income under the 75% or 95% income tests (or any property which generates such income or gain), provided the transaction is clearly identified as such before the close of the day on which it was acquired, originated, or entered into (or such other time as IRS may prescribe). Such income is excluded from gross income for purposes of both tests. (Code Sec. 856(c)(5)(G)(ii))

For tax years beginning after the enactment date, the Act authorizes IRS to issue guidance that would allow other items of income to be excluded for computation of qualifying gross income under either test, respectively, or to be included as qualifying income for either test, in appropriate cases consistent with the purposes of the REIT provisions. (Code Sec. 856(c)(5)(J), as amended by Act § 3031(c))

 

Changes Easing REIT Asset Test

At least 75% of the value of a REIT's assets must be real estate assets, cash and cash items (including receivables), and Government securities (the “75% asset test”). No more than 25% of a REIT's assets may be securities other than such real estate assets.

Except for a taxable REIT subsidiary, not more than 5% of the value of a REIT's assets may be securities of any one issuer, and the REIT may not possess securities representing more than 10% of the outstanding value or voting power of any one issuer. In addition, (except for certain timber REITs for a limited time period), not more than 20% of the value of a REIT's assets may be securities of one or more taxable REIT subsidiaries.

The asset tests must be met as of the close of each quarter of a REIT's tax year. However, a REIT that has met the asset tests as of the close of any quarter does not lose its REIT status solely because of a discrepancy during a subsequent quarter between the value of the REIT's investments and such requirements, unless the discrepancy exists immediately after the acquisition of any security or other property and is wholly or partly the result of the acquisition.

New law. For tax years beginning after the enactment date, the Act clarifies the rule that if a REIT has met the asset tests as of the close of any quarter it will not fail them solely because of a discrepancy due to variations in value that are not attributable to the acquisition of investments to include a discrepancy caused solely by the change in the foreign currency exchange rate used to value a foreign asset. (Code Sec. 856(c)(4)(B)(iii)(III), as amended by Act § 3032(a))

The Act defines the term “cash” for purposes of the REIT asset qualification rules to include foreign currency if the REIT or its QBU uses such currency as its functional currency, but only to the extent such foreign currency is held for use in the normal course of the activities of the REIT or the QBU giving rise to income or gain described in Code Sec. 856(c)(2) or Code Sec. 856(c)(3), or directly related to acquiring or holding assets described in Code Sec. 856(c)(4), and is not held in connection with a trade or business of trading or dealing in securities. (Code Sec. 856(c)(5)(K), as amended by Act § 3032(b))

 

Changes to REIT Prohibited Transaction Tax

REITs are subject to a prohibited transaction tax (PTT) of 100% of the net income derived from prohibited transactions. For this purpose, a prohibited transaction is a sale or other disposition of property by the REIT that is “stock in trade of a taxpayer or other property which would properly be included in the inventory of the taxpayer if on hand at the close of the tax year, or property held for sale to customers by the taxpayer in the ordinary course of his trade or business” and is not foreclosure property. The PTT for a REIT does not apply to a sale if the REIT satisfies certain safe harbor requirements in Code Sec. 857(b)(6)(C) or Code Sec. 857(b)(6)(D) , including an asset holding period of at least four years (2 years for certain sales of timber property for a limited time period). If the conditions are met, a REIT may either (i) make no more than 7 sales within a tax year (other than sales of foreclosure property or involuntary conversions under Code Sec. 1033), or (ii) sell no more than 10% of the aggregate basis of all its assets as of the beginning of the tax year (computed without regard to sales of foreclosure property or involuntary conversions under Code Sec. 1033), without being subject to the PTT tax.

New law. Under the Act, for gains and deductions recognized after the enactment date, foreign currency gain under Code Sec. 988(b)(1) , or loss under Code Sec. 988(b)(2) , that is attributable to any prohibited transaction is taken into account in determining the amount of prohibited transaction net income subject to the 100% tax.

The Act shortens from four years to two years the minimum holding period under the prohibited transactions tax safe harbors of Code Sec. 857(b)(6)(C) and Code Sec. 857(b)(6)(D). The requirement that timber property under section Code Sec. 857(b)(6)(D) be sold to a qualified organization (as defined in Code Sec. 170(h)(3)) exclusively for conservation purposes in order for the 2-year holding period to apply under the safe harbor, and the one-year limited application of the 2-year holding period rule under Code Sec. 857(b)(6)(D), are generally removed. The Act makes clear that the safe harbor is an exception from the prohibited transactions tax only, and does not cause a gain on a sale that otherwise does not qualify for capital gains treatment to become a capital gain transaction. However, in the case of timber property under Code Sec. 857(b)(6)(D), the provision retains for the one-year period prescribed in the Farm Act the rule that qualification of the sale under the safe harbor also means that the sale is considered to be a sale of property held for investment or use in a trade or business, and not of property described in Code Sec. 1221(a)(1) , for all purposes of subtitle A of the Code, but only if the sale would have qualified under Code Sec. 857(b)(6)(D) as in effect before the enactment of the provision. (Code Sec. 857(b)(6), as amended by Act § 3051(a))

For tax years beginning after the enactment date, the Act changes the prohibited transactions tax safe harbor provisions concerning maximum amount of sales within a tax year that are consistent with the alternative prohibited transactions tax safe harbor (that is an alternative to the test for no more than 7 sales). Instead of the pre-Act alternative limit of 10% of the aggregate basis of all the assets of the REIT as of the beginning of the tax year, the limit under the Act is either 10% of such aggregate basis or 10% of the aggregate fair market value of all the assets of the REIT as of such time. (Code Sec. 857(b)(6)(D)(iv), as amended by Act § 3052)

 

Changes Affecting Taxable REIT Subsidiaries

A REIT generally cannot own more than 10% of the vote or value of a single entity; however, there is an exception for ownership of a taxable REIT subsidiary (TRS) that is taxed as a corporation, provided that securities of one or more TRSs do not represent more than 20% of the value of REIT assets.

A TRS generally can engage in any kind of business activity except that may not directly or indirectly to operate either a lodging facility or a health care facility. However, a TRS may rent hotel, motel, or other transient lodging facilities from its parent REIT and may hire an independent contractor to operate such facilities.

Furthermore, rent paid to the parent REIT by the TRS with respect to hotel, motel, or other transient lodging facilities operated by an independent contractor is qualified rent for purposes of the income tests.

New law. For tax years beginning after the enactment date, the Act increases the percentage of the value of REIT assets that can be held in securities of a taxable REIT subsidiary to 25%. (Code Sec. 856(c)(4)(B)(ii), as amended by Act § 3041)

For tax years beginning after the enactment date, the Act expands the taxable REIT subsidiary exception for hotel, motel, and other transient facilities so that it also applies to health care facilities. Thus, a taxable REIT subsidiary may rent a health care facility from its parent REIT and hire an independent contractor to operate such a facility; the rents paid to the parent REIT are qualifying rental income for purposes of the income tests. (Code Sec. 856(d)(8), as amended by Act § 3061(a))

Under the Act, a taxable REIT subsidiary is not to be considered to be operating or managing a qualified health care property or a qualified lodging facility other than through an independent contractor solely because the taxable REIT subsidiary directly or indirectly possesses a license, permit, or similar instrument enabling it to do so. (Code Sec. 856(d)(8))

Under the Act, a taxable REIT subsidiary is not to be considered to be operating or managing a qualified health care property or qualified lodging facility solely because it employs individuals working at such property or facility located outside the U.S., but only if an eligible independent contractor is responsible for the daily supervision and direction of the individuals on behalf of the taxable REIT subsidiary pursuant to a management agreement or similar service contract. (Code Sec. 856(d)(8))

 

Alternate Procedure Provided for
Nonforeign Affidavits Under FIRPTA Rules

Under the Foreign Investment in Real Property Tax Act (FIRPTA) rules in Code Sec. 897, a nonresident alien or a foreign corporation is generally taxed on gain realized from a disposition of an interest in U.S. real property (USRPI) as if that gain or loss were effectively connected to a U.S. trade or business carried on by that person during the year. Although the tax is imposed upon the dispositions on a net basis, the transferee of a USRPI is generally required to deduct and withhold tax equal to 10% of the amount realized.

Under one of several exceptions under pre-Act law, a transferee is not required to withhold if the transferor furnishes the transferee with an affidavit stating, under penalties of perjury, the transferor's U.S. taxpayer's identification number (i.e., social security number or entity identification number (EIN)) and that the transferor is not a foreign person (nonforeign affidavit or affidavit).

New law. For dispositions of USRPIs after the enactment date, the Act provides an alternative procedure for furnishing the nonforeign affidavit. Under this procedure, instead of furnishing a nonforeign affidavit to the transferee, a transferor may furnish the affidavit to a “qualified substitute.” The qualified substitute is then required to furnish a statement (the “statement”) to the transferee stating, under penalties of perjury, that the qualified substitute has the affidavit in his possession. ( Code Sec. 1445(b)(9)(A), as amended by Act § 3024(a)) A qualified substitute is the person (including any attorney or title company) responsible for closing the transaction (other than the transferor's agent), and the transferee's agent. (Code Sec. 1445(f)(6))

The alternative procedure doesn't apply to any disposition if the transferee or the qualified substitute has actual knowledge that the affidavit or statement is false; receives a notice from a transferor's agent, transferee's agent or qualified substitute that the affidavit or statement is false; or is required to furnish a copy of the affidavit or statement to IRS and fails to do so at the time and in the manner required. (Code Sec. 1445(b)(7))

The agent or qualified substitute must notify the transferee, as required by regs, if the transferor furnishes an affidavit to the transferee or qualified substitute or a domestic corporation furnishes an affidavit to the transferee and (1) the transferor's agent has actual knowledge that the affidavit is false or the corporation is a foreign corporation, or (2) a transferee's agent or qualified substitute has actual knowledge that the affidavit is false. (Code Sec. 1445(d)(1))

If any transferor's agent, transferee's agent or qualified substitute is required to furnish notice but fails to timely do so, the agent or qualified substitute has the same duty to deduct and withhold that the transferee would have had if the agent or qualified substitute had complied with the notice requirements. An agent's or substitute's liability is limited to the amount of compensation the agent or substitute receives from the transaction. (Code Sec. 1445(d)(2))

Congress intends that regs will require the qualified substitute and the transferee to retain documentation for a period commensurate with the period required by the regs currently in effect (i.e., 5 years). (Committee Report)

 

Modified Estimated Tax Payment Rules
For Large Corporations

The Act makes two changes in the estimated tax payment rules for large corporations (those with assets of $1 billion or more):

(1) It repeals the changes made by prior legislation for required installments of estimated tax for July, August, and September of 2012. Thus, large corporations will make regular estimated tax payments for these installments based on their income tax liability. (Act § 3094(a))

(2) It increases the required installments of estimated tax for July, August, and September of 2013, as in effect on the enactment date, by 16.75%, with corresponding reductions in the next required payment. (Act § 3094(b))

 

Election to Include Reimbursement for
Hurricane-related Casualty in Loss Year

Casualty losses are generally allowed for the tax year of the loss. For a disaster loss arising in an area determined by the President to warrant assistance by the Federal Government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act, a taxpayer may elect to take the loss into account for the tax year immediately before that in which the disaster occurred. Under pre-Act law, Reg. § 1.165-1(d)(2)(iii) provides that when a taxpayer receives reimbursement for such loss in a later tax year, the deductible loss isn't recomputed for the tax year in which the deduction was taken. Instead, the reimbursement amount is taken into income in the tax year received.

New law. The Act allows a taxpayer who claimed a casualty loss to a principal residence (within the meaning of the Code Sec. 121 homesale exclusion rules) from Hurricanes Katrina, Rita, or Wilma, and in a later year receives a grant under Public Laws 109-148, 109-234, or 110-116 as reimbursement of that loss, to elect to file an amended return for the tax year to which the deduction was allowed. On the amended return, the casualty loss deduction must be reduced, but not below zero, by the amount of the reimbursement. The amended return must be filed by the later of three years after the original due date for filing the tax return or four months after the enactment date. Any tax underpayment is subject to one year of interest, but no penalty or additional interest applies if payment is made no later than one year after the filing of the amended return. (Act § 3082(a))

 

Deadline for Bonus Depreciation on
Construction of GO Zone Property Is Waived

Taxpayers can claim an additional (i.e., bonus) first-year depreciation allowance equal to 50% of the adjusted basis of qualified Gulf Opportunity Zone (GO Zone) property. To qualify property must generally meet detailed use requirements and be placed in service by the taxpayer before 2008 (before 2009 for nonresidential real property or residential rental property). A special exception applies for “specified GO Zone extension property”—property in IRS-identified areas in which 2005 hurricanes damaged more than 60% (in the aggregate) of the occupied housing units. Here, nonresidential real property or residential rental property can be placed in service before Jan. 1, 2011 (but bonus depreciation is limited to the adjusted basis attributable to manufacture, construction or production before Jan. 1, 2010—the progress expenditure rule) and certain property in those buildings can be placed in service 90 days after that.

Under pre-Act law, Code Sec. 1400N(d)(3)(B) provided that property that is manufactured, constructed, or produced by the taxpayer for use by the taxpayer qualifies for bonus depreciation if the taxpayer begins the manufacture, construction, or production of the property on or after Aug. 28, 2005 and before Jan. 1, 2008, and the property is placed in service on or before Dec. 31, 2007 (and all other requirements are met). In the case of qualified nonresidential real property and residential rental property, the property must be placed in service on or before Dec. 31, 2008. Property that is manufactured, constructed, or produced for the taxpayer by another person under a contract that is entered into prior to the manufacture, construction, or production of the property is considered to be manufactured, constructed, or produced by the taxpayer.

New law. For property placed in service after 2007, the Act removes the Jan. 1, 2008 date for beginning the manufacture, construction, or production of self-constructed GO Zone property. (Code Sec. 1400N(d)(3)(B), as amended by Act § 3082(b)) Thus, the Act removes this date for purposes of self-constructed GO Zone extension property. The placed in service date of Dec. 31, 2010 and the progress expenditure date of January 1, 2010 are not changed. (Committee Report)

Observation: Because the elimination of the self-constructed property rule is effective retroactively for all property placed in service after 2007, a taxpayer who filed a return in which he didn't treat otherwise-eligible property as qualified GO Zone property, should consider filing an amended return.

 

Two Additional Counties Included in
GO Zone for Bond Purposes

The Gulf Opportunity Zone Act of 2005 provided a number of tax benefits for areas affected by Hurricanes Katrina, Wilma and Rita. Under pre-Act law, Alabama, Louisiana and Mississippi were authorized to issue certain tax-exempt facility bonds and qualified mortgage bonds for property located in the GO Zone (GO Zone bonds). In Alabama, Baldwin, Chocktaw, Clarke, Greene, Hale, Marengo, Mobile, Pickens, Sumter, Tuscaloosa and Washington counties were identified as warranting individual or individual and public assistance:

New law. For bonds issued after Dec. 21, 2005 and before Jan. 1, 2011, for tax years ending after Aug. 27, 2005, the Act also includes Colbert County and Dallas County, Alabama, in the GO Zone for GO Zone bond purposes only. (Act § 3082(c))

Observation: The Act provision is effective as if included in § 101(a) of the 2005 Gulf Opportunity Zone Act, i.e., the provision to which the above rule relates.

 

Tax Credits and Financing Mechanisms for Housing

The Act's changes for low-income housing credits, rehab credits, and housing bonds include the following:

• The state-by-state limit on the annual amount of Federal low-income housing tax credits that may be allocated by each state is increased from $2 per person to $2.20 per person for 2008 and 2009. States with small populations are provided with a special set-aside. The Act increases the small state set-aside by 10%. (Code Sec. 42(h), as amended by Act § 3001)
  
• The Act carries numerous changes to the technical rules relating to low income housing tax credits. (Act §§ 3002 to 3004)
  
• For expenses properly taken account for periods after Dec. 31, 2007, the Act allows taxpayers to qualify for the full amount of the rehabilitation credit so long as less than 50% of the rehabilitated building (increased from 35%) is leased to State and local governments or other tax-exempt entities. (Code Sec. 47, as amended by Act § 3025)
  
• The Act increases the national limit on the annual amount of tax-exempt housing bonds that each state may issue. The national limit for 2008 is increased to allow for the issuance of an additional $11 billion of tax-exempt bonds to provide loans to first-time home buyers and to finance the construction of low-income rental housing. The Act also temporarily allows qualified mortgage revenue bonds to be used to refinance certain subprime loans. (Code Sec. 142, Code Sec. 143, Code Sec. 146, as amended by Act § 3021)
  
• The Act also temporarily allows qualified mortgage revenue bonds to be used to help individuals purchase new homes in Presidentially-declared disaster areas. (Code Sec. 143, as amended by Act § 3026)